you're still taking on the risk of waking up one morning to an accounting scandal rendering 5% of your portfolio worthless. unless you diversify so much that you're essentially an index investor anyway. the stock market isn't rigged against retail investors like many believe, but people are far too quick to assume a few years of good performance means they're "beating the market".
When it comes to picking out frauds, you can usually tell by looking at the accounting who is playing loose and who is not. That wont give you an indication of whether or not a company is necessarily a fraud, but it will give you the opportunity to know who is being aggressive with their accounting. And if they are being aggressive you should probably stay away.
There are a ton of books out there on forensic accounting (Financial Shenanigans, Creative Cash Flow Reporting, Quality of Earnings, Financial Fine Print -- Along with changes to GAAP and IFRS) where if you have read all of them you should be able to pick out weird issues with accounting.
The other benefit of investing in small companies is you can in general get better access to CEOs and managers. If you were to invest in JNJ, the chance of you getting to talk to the CEO is slim. But with a lot of nano-cap companies you can actually go visit with the CEO and start quizzing him to see if he is BSing you or if he is actually smart and competent. I like to ask the same questions to two competing CEOs and see how their answers differ. You can really go as deep as you want when investigating some CEOs. You can start visiting their community, talking to people who are active with them in organizations. Just a lot of work to really scrub their background and get at who they are. Plus, these businesses tend to have fewer moving parts too, so you can analyze them in greater detail.
